Unsecured and secured loans explained

Money 2015-10-15

When you’re comparing loans, there are lots of questions you need to ask yourself. How much you’d like to borrow? What time frame do you want to pay it back over? Can you afford the monthly repayments comfortably? Are there any set up fees?

But one of the most important questions you need to consider is will you opt for an unsecured or secured loan?

Here we explain the pros and cons of both to help you make the right decision.

What's the difference?

Secured Loans are asset backed, meaning you provide some form of security to the lender, normally your home (mortgaged or owned outright) and if you fail in your repayments then the lender can potentially sell your home to get their money back. The value of your assets will be considered when deciding how much you can borrow and is likely to effect the interest rate you are given.

In comparison, unsecured loans don’t require you to put up any form of collateral. Instead, lenders use a set of risk-based criteria to assess how likely you are to default on your loan and determine how much you can borrow, at what rate of interest. If you default with your payments you’re less likely to lose your home, car or any other asset. However, you’re still required to pay off your loan within an agreed period .

Typically, unsecured loans are used for borrowing smaller amounts, over shorter time frames. Normally you can borrow up to £25,000 over up to five years on an unsecured loan and up to £250,000 over as long as 20 years on a secured loan.

What are the advantages of a secured loan?

As long as you’re a mortgage holder or property owner, a secured loan is a good way to borrow large amounts of money. Depending on where you go, you could get anything up to £250,000 – but this will depend on your home equity, personal circumstances and ability to pay it back.

You can also arrange to repay the money you borrowed over a longer period, like 20 years. While this might reduce your monthly repayments, you’ll end up paying more in interest in the long run.

It’s also an option if you have a poor credit history or are self- employed as unsecured loans, especially those with a decent interest rate, is often out of reach for people with less than perfect credit scores.

What are the disadvantages of a secured loan?

The biggest disadvantage of secured loans is that if your circumstances change and you are unable to meet repayments you put your home at risk, so it is essential you don’t fall behind with payments. Terms and conditions can be detailed and lengthy, but as with any contract you enter into you must check them thoroughly.

Most secure loans have a variable rate of interest, which means your monthly repayments will increase or decrease depending on the base rate set by the Bank of England. This can work to your advantage if the base rate drops, but as secured loans tend to be taken out over longer periods, the chances are you will experience some rises. So it’s important that you work out whether you could still meet repayments if they increased significantly.

Secured loans are also notoriously difficult to repay early, often incurring a penalty charge.

What are the advantages of an unsecured loan?

They’re easier to get – you don’t need to own a property to get an unsecured loan. They’re also less risky since you’re not securing your home (or any other asset) against the money you borrow.

Although each lender will vary their amounts and repayment periods, you can generally borrow anything from £1,000 to £25,000 and repay it within 1-5 years.

With an unsecured loan you also know exactly how much you need to pay each month, as they tend to offer a fixed interest rate, so you can budget accordingly.

What are the disadvantages of an unsecured loan?

Lenders need to know that their money is going to get paid back in full and within the agreed period, therefore if you’ve got a less-than-perfect credit history you might struggle to qualify.

Although there’s less risk with an unsecured loan, if you fall behind on repayments, this could affect your credit score, which means you may find it difficult to borrow again in the future.

What to consider

The pros and cons of secured and unsecured loans are useful to consider when deciding which is best for you, but ultimately it is your personal circumstances which will have the biggest impact on your choice.

When choosing a loan you need to be very clear on how much you want to borrow, and how quickly you can pay it off. Use a loan calculator to check the APR and total amount repayable. It’s important to arrange a repayment period that’s right for you.

Above all else, consider your income and plan ahead. Be realistic about what you can afford and what you’re putting at risk.

Hitachi Hints and Tips is intended to be informative and interesting. It does not constitute financial advice, and you should always do further research when making any financial decisions. All information was correct at date of publication.